1
2	Understanding What We Have Learned A working knowledge of the tax techniques we learned in chapter four is necessary for a complete, comprehensive, understanding of real estate. Understanding the needs of our investors is tantamount to serving the real estate owning public. If you master these techniques you will be a more valuable real estate professional.
3	What You Should Learn In this chapter you should learn the following; The initial effect of tax benefits on real estate investments. The long term effect of tax benefits on real estate investments. The final effect of tax benefits on real estate benefits.
4	Our Example In 1987 Jim and Laura Hankins purchased a four plex in Anaheim California. The purchase price was $275,000. The Hankins put 20% of the purchase price as a down payment, or $55,000 as a Cash Down Payment. The Hankins obtained a new 1^st Trust Deed and Note in the amount of $220,000 at 9% interest, amortized for 30 years and payable in equal monthly installments of $?,???.??
5	Finding The Payment Here we can find the payment by using a financial Tables Book. We can use a constant, normally a constant for $1,000 at the given rate. In this example 30 years at 9% interest would give us a loan constant of $8.05 per $1,000 of loan. In our example we would divide the $220,000 loan by $1,000 which would give us 220. This 220 would represent how many 1,000 bills are in a $220,000 loan. Next we would multiply 220 by the $8.05 Loan Constant and come up with $1,770.17.
6	Finding The Payment The method most of us will use is the financial calculator. If we use the HP 17B we would have the following; n i PV PMT FV OTHER 360 9 220,000 ? 0 Then you would solve for the PMT and get; n i PV PMT FV OTHER 360 9 220,000 -1,770.17 0
7	Unit Mix and Rents The four plex consists of; One – 3 Bedroom, 1¾ Bath Unit Two - 2 Bedroom, 1¾ Bath Units One - 2 Bedroom, 1½ Bath Unit The rents at purchase are as follows; 3 Bedroom, 1¾ Bath Unit = $700 per month 2 Bedroom, 1¾ Bath Unit = $650 per month 2 Bedroom, 1½ Bath Unit = $600 per month
8	Expenses and Vacancy Factors The Expenses of Operation have been 25% of the Gross Scheduled Income. The Vacancy Factor has been 2% of the Gross Scheduled Income.
9	Estimate the Cash Flow and Value At Purchase Gross Scheduled Income $ Vacancy Factor 2% ($ ) Gross Operating Income $ Expenses of Operation ($ ) Net Operating Income $ 1^st Trust Deed & Note ($ ) = $220,000 @ 9% Interest Sub-Total Net $ 2^nd Trust Deed & Note ($ ) Cash Flow $ Total Loans $220,000 Cash Down Payment 20% $ 55,000 Purchase Price of Building $275,000 Capitalization Rate = % Gross Rent Multiplier = Per Unit Value = $
10	Estimated Tax Picture at Purchase Purchase Price of Building $275,000 Improvement Value Estimated to be 70% of Purchase Price = $275,000 X 70% = $
11	Find the Year 1 Interest Payment With your financial calculator or from the tables in financial books you will find the interest paid the 1^st year of the loan. A remaining balance table, page 212 of the Blue Book, would tell us that a 30 year loan, after one year of payments would have a balance of 99.3%, or $220,000 X 99.3% = $218,460 The actual multiplier would be 99.3168026% A financial Calculator will give us $218,496.97
12	Find the Year 1 Interest Payment - 2 Then to find the interest we find the principal that has been paid, and subtract that principal from the total payments; Original Loan - Year End Balance = Principal Paid $220,000 - $218,496.97 = $1,503.03 Total Payments = Monthly Payment X 12 Months = Annual Payments $1,770.17 X 12 Months = $21,242.04 Total Payments - Principal = Interest $21,242.04 - $1,503.03 = $19,739.01
13	Tax Picture Year 1 Gross Scheduled Income $ Vacancy Factor 2% ($ ) Expenses of Operation ($ ) Interest 1^st Trust Deed ($ ) Depreciation ($ ) Total Deductions ($ ) ($ ) Net Tax Loss or Gain ($ )
14	Tax Savings 32% Marginal Bracket Find the Estimated Tax Savings Year I: Estimated Tax Savings ($ ) Times Marginal Tax Bracket X 32% Estimated Tax Savings Year I $
15	Four Returns Year 1 Four Classic Returns: Cash Flow $ Tax Savings $ Equity Buildup $ Appreciation $ Total Returns $ Total Returns divided by Down Payment $ ¸ $55,000
16	Estimated Building Value 1988 1989 1990 1991 Estimated Bldg. Value $ $ $ $ Less Loans ($ ) ($ ) ($ ) ($ ) Gross Equity $ $ $ $
17	Cash Flow Projections Years 2 – 5 5% Annual Rent Increases 1988 1989 1990 1991 GSI $ $ $ $ Vacancy 2% ($ ) ($ ) ($ ) ($ ) GOI $ $ $ $ Expenses ($ ) ($ ) ($ ) ($ ) NOI $ $ $ $ 1^st T.D. ($ ) ($ ) ($ ) ($ ) STN $ $ $ $ 2^nd T.D. ($ ) ($ ) ($ ) ($ ) CF Total Loans
18	Estimated Returns Years 2 to 5 1988 $ $ $ $
19	17 Year Value @ 5% Annual Appreciation In our example the Hankins purchased the building in 1987. For arguments sake we will say that this is 17 years ago. At 5% annually, the value would be: Future Value (1+i)ⁿ = (1.05)^17 = 2.292018 If we multiply the Original Value of $275,000 by 2.292018 we will come up with; Original Future Value X Value Factor = Future Value $275,000 X 2.2920 = $630,305.04 That is uncannily accurate
20	Adjusted Tax Basis Since earlier we came to the conclusion that the building was worth 70% of the total purchase price, and that this is residential income property so we have 27½ Years Depreciation, we had the following;
21	Adjusted Tax Basis - 2 Since Mr. and Mrs. Hankins have had the building for 17 years, we can assume that they have depreciated $119,000
22	Find The Potential Gain Upon Sale Selling Price of Building $630,000 Less Expenses of Sale 8% ($ 50,400) Less Adjusted Tax Basis ($156,000) Potential Gain $423,600
23	Estimating the Taxes Taxable Gain $423,600 Federal Taxes = 20% of $423,600 = $ 84,720 State of California Taxes = 5.5% of $423,600 = $ 23,265 Total Taxes State and Fed $107,875 Now we need to look at our after sale, after tax net from the sale of this building.
24	After Sale, After Taxes Net Selling Price $630,000 Expenses of Sale 8% ($ 54,400) Less Loans of Record ($162,449) Less Estimated Taxes ($107,875) Estimated Net Cash, Close of Escrow $305,276
25	The Decision to Sell Often Never Comes You can see that the decision to sell never comes with some investors. Still people do sell. You have to be aware of the consequences of the sale. What if the owner could sell the property, carry the paper, and have a lower immediate rate of taxes on sale? This is called the Installment Sale and is well worth looking at.
26	The 1031 Tax Deferred/Refinance Dilemna We run into the same problem when an owner has to make the decision to Exchange all of their equity into another investment property, or refinance their current investment property and purchase another. Later in this class we will review the wisdom of Exchange/Refinance Purchase.
27
28